OECD warns about damages caused by support to zombie companies

In a recent analysis, the OECD warned about the effects that countries may have for granting support to zombie companies.

Zombie companies, as they are often called, are companies that would have defaulted in a normal business cycle, but continue to operate due to an ultra-low interest rate environment.

Market forces cannot always lead to efficient resource allocation.

Therefore, in the opinion of the OECD, economic recovery can be much slower when zombie companies remain operational.

Zombie companies are less productive, more leveraged, and unable to invest.

Economists define a zombie company as one that is at least 10 years old, but cannot cover its costs with its profits.

Since the financial crisis, these companies have incurred a huge amount of debt as loans became cheap due to low interest rates.

Zombie companies

According to the OECD, misdirected government support or additional bank loans to avoid cancellations that could harm banking institutions can prevent these companies from exiting.

Also the significant presence of zombie companies also contributed to Japan‘s «lost decade» in the 1990s.

Research by Ricardo Caballero shows that banks, unwilling to recognize losses, given the implications on their regulatory capital limits, extended credit to these otherwise insolvent companies.

Another similar story is found after the global financial crisis. Fabiano Schivardi’s research shows, based on a database of bank-business relationships in Italy in the period 2008-2013, that undercapitalized banks diverted credit in a way that contributed to the survival of zombie companies and the failure of companies. otherwise healthy.

“Market forces may not guarantee that financing will necessarily flow to viable and efficient companies facing temporary financial difficulties. Therefore, well-designed state support can be important in such cases,” recommended the OECD.

Once the economic situation is stable, governments will have to withdraw from the support measures taken during the crisis.

Government support can create dependency and should be abandoned as soon as conditions allow governments to obtain good value for money for taxpayers and conditions for competition are secured.